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What are Debt Instruments?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 18 November 2016
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Debt instruments are hard copy or electronic documents that commit the issuer to repaying a lender according to the terms and conditions of a contract. Classic examples of debt instruments allow the issuer to raise money with this type of financial arrangement, often for the purpose of funding a project or retiring one or more debts. Businesses and individuals may lend and borrow using a debt instrument as the document that gives form to the obligation.

One of the more common types of debt instruments is the certificate of deposit, or CD. Issued by banks and other financial institutions, this obligation effectively allows the depositor to act as the lender. The financial institution, as the recipient of the loan, is free to make use of the deposited funds in exchange for periodically adding an interest payment to the lender’s account, using the schedule documented in the contract. At specific points in the life of the CD, the lender is free to remove his or her funds from the institution, including any interest that has accrued. Since this type of obligation pays a higher rate of interest than some other savings plans, the CD is a popular choice for anyone who favors low-risk investments.

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Mortgages are another example of common debt instruments. Here, a financial institution lends the funds to a borrower, with the understanding that the debtor will repay the total amount of the loan, plus interest. This typically occurs over a number of years, and follows a schedule of monthly installment payments. A mortgage allows the borrower to enjoy the benefits of owning the asset, even though the lender continues to hold the title until the debt obligation is fully fulfilled.

Bonds also qualify as debt instruments. The bond may be a corporate bond, issued to fund a project of either short or long duration. The instrument may be in the form of a government bond, issued either by a local municipality to fund some type of community improvement project, or by a federal government as a means of raising funds for some type of ongoing project. Bonds can be structured in several different ways, but always tend to provide the lender with a return of the original investment plus some amount of interest.

There are other forms of debt instruments that are used from time to time. Promissory notes are simple obligations that are sometimes utilized for short-term lending situations. Commercial papers and banker’s acceptances are also options for quick lending situations, depending on the credit ratings and general financial stability of the two parties involved. While the specifics of the instruments vary somewhat, all these obligations do provide the lender with some type of additional funds along with the repayment of the principle, thus making the deal profitable for everyone concerned.

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